The Market Today
Fed Keeps It on Cruise Control: No Acceleration, No Pause
by Craig Dismuke, Dudley Carter
2Q GDP Holds at 4.2% But Inventories Setting up for Even Bigger 3Q Rebound: The economy grew 4.2% in the 2nd quarter according to the final revision to the report. There was one revision worth noting in the underlying data. Inventories were revised down by an additional $9.9 billion meaning that the 3Q inventory rebound could be even more substantial (a positive tailwind for 3Q growth).
Inventory Growth on Pace to Rebound Strongly in 3Q: In fact, the August Wholesale Inventory report blew out expectations this morning, rising 0.8% during the month (exp. +0.3%). August’s Retail Inventories data also beat expectations, rising 0.7% MoM in August after a 0.6% increase in July. The inventory rebound is almost certain to provide a meaningful boost to 3Q GDP.
Goods Trade Deficit Jumps $5 BN More than Expected: This is the good news, the bad news is that the rebound in the trade deficit is likely to weigh just as much on 3Q GDP. After the trade deficit boosted 2Q GDP by 1.28% as it shrunk on an anomalous, tariff-related increase in exports, the deficit is likely to reverse in 3Q. Sure enough, August’s Advanced Goods Trade Balance report showed the goods deficit jumped $3.8 billion which was $5.2 billion more than expected.
Durable Goods Orders Data Shows Solid 3Q, Weaker Future Activity: August’s preliminary report on Durable Goods Orders beat expectations at the headline level, but masked a discouraging report on core capital goods orders. The headline beat came from a big jump in nondefense aircraft (+69% MoM) as well as defense aircraft (+17% MoM). Looking at what matters to the 3Q business investment numbers, core capital goods orders fell 0.5% MoM which was a full percent below the 12-month run rate. That bodes poorly for future business investment in equipment. However, shipments of those same items were up 0.1% MoM, still weak but not as weak. Shipments, a reflection of current business investment, point to another strong quarter for the category in 3Q.
Stocks Drop as Investors Digest Fed on Autopilot: The markets were a bit more skittish after the blissfully optimistic Fed announcement yesterday, with stocks turning lower as investors digested the news and bond yields pulling lower as well. The first reaction came from Treasurys with the 10-year yield dropping from 3.09% to 3.05% quickly after the announcement. Likewise, the 2-year Treasury yield dropped from 2.83% to 2.81% allowing the curve to flatten a few basis points. After a small pullback initially, stocks eventually began to drop as investors saw no signs of a Fed pause. For the day, the Dow ended down 107 points and the S&P fell 9.6 points. The 10-year yield fell 4 bps, remaining in its 3.04-3.11 range, although it has tested the low end of that range overnight. The 2-year yield fell 2.5 bps. There was plenty of talk yesterday evening that the short-end of the yield curve is failing to price in as many Fed hikes as we may see. In a note to clients, Goldman Sachs said they now expect four rate hikes this year followed by four next year, a terminal rate of 3.25-3.50%, and risk to the upside. If this were to prove correct, the 2-year yield should arguably trade closer to 3.00% than its current 2.83%. However, the weakness in stocks yesterday proved to be a key takeaway – stocks pulled back for the fourth consecutive time on a rate hike. At some point, tightening financial conditions from Fed rate hikes are likely to become a compelling enough reason to pause their quarterly grind higher.
FOMC Avoids Tacking to the More Hawkish Side: The FOMC voted unanimously to hike for the eighth time of this cycle to 2.00-2.25%. Also as expected, the Committee increased its balance sheet roll-off to allow $50 billion per month in portfolio roll-off, $30 billion in Treasury securities and $20 billion in MBS. According to the originally prescribed plans, this is expected to be the maximum portfolio roll-off allowed going forward.
As for the FOMC’s Official Statement, there were remarkably few changes to the strong assessment from the August Statement. The only changes were mechanical in nature with one exception, the Committee no longer considers policy to be “accommodative.”
The Summary of Economic Projections showed that FOMC opinion has coalesced around four rate hikes for 2018 bringing the expected year-end target range to 2.25-2.50%, up from the expected three hikes coming into the year. As such, the Fed is continuing to project 4 rate hikes for 2018, 3 in 2019, and 1 additional in 2020. There were concerns coming into the announcement that Fed officials might project a faster pace of tightening; but this was not the case.
The SEP also provided the first look at 2021 forecasts and participants expect the overnight range to remain at the year-end 2020 range of 3.25-3.50% in 2021, implying that this is the expected peak range for the overnight rate. The median longer run rate did bump up from 2.875% to 3.00%, but not because participants raised their projections. Instead, new Fed Governor Clarida added one projection to the high side of the median, bumping the median higher. GDP growth is now projected to be stronger in 2018 and 2019 than previously projected.
The economy is expected to grow 3.1% in 2018 (up from 2.8%) and 2.5% in 2019 (up from 2.4%). While shorter term growth is expected to be stronger, the 2021 projections show growth slowing to 1.8%. Unemployment is expected to begin rising in 2021 but inflation is expected to remain in-check at 2.1%. This marks the first forecast since the Dot Plot was introduced in 2012 in which the unemployment rate is projected to rise at a future date.
Bottom line: The FOMC’s outlook remains very positive with stronger-than-sustainable growth through 2019, lower-than-sustainable unemployment through 2021 at least, and inflation in-line with their 2.0% target. Despite the strong outlook, FOMC officials did not raise their collective overnight rate projections and signaled that 3.25-3.50% may be the peak Fed Funds range during this cycle. With the risks tilted toward a more hawkish FOMC, these results were fractionally on the dovish side of expectations. Nonetheless, the fact that Fed officials continue to project a faster-than-expected path than the markets finally caught up to stocks, which turned lower as investors digested the news.
New Home Sales Beat Expectations for a Change, But Previous Data Revised Lower: August’s New Home Sales report showed sales up a better-than-expected 3.5% MoM. However, the annualized pace of sales rose to just 629k which was 1k worse than expectations. May, June, and July’s sales figures were revised lower than previously reported causing the weaker result. The new home sales data show an even weaker summer for new home sales, adding to the recent run of disappointing housing data. Nonetheless, the uptick in August’s sales at least offers some solace.